Smart & Final’s Stock Slide May Spell Opportunity
When a company’s management team has a rosy view of the future, but the firm’s majority shareholder doesn’t intend to stick around for it, you’ve got a big potential problem. And maybe an opportunity as well.
That’s the background for the slide in shares of Santa Barbara-based warehouse grocer Smart & Final Inc. since summer. The stock, $20.125 at its peak earlier this year, has tumbled recently to as low as $11.375 and closed Thursday at $12.50.
Slightly more than 50% of S&F;’s 20.5 million shares are owned by Casino USA, the U.S. arm of French retail giant Groupe Casino. In July, the French parent publicly announced plans to sell its U.S. interests, which it has owned since 1984, to focus on European operations.
By most accounts, Casino’s decision to hang out a for-sale sign for all to see was a major blunder. “Very naive” is how Jim Craig, money manager at Janus Capital in Denver and an S&F; shareholder, characterizes the French move.
Why? By advertising its intentions instead of quietly shopping around for a possible buyer, Casino cast a shadow over S&F; stock. Smaller investors suddenly had to worry that Casino, in wanting out, knew something they didn’t. Also, the possibility that no buyer would surface raised other fears: Would Casino then sell piecemeal? Was the stock overpriced to begin with?
Sure enough, all of those fears have helped drag down S&F; shares since July, even as the stock market overall hit new highs. On Tuesday of this week, Casino finally gave up: It announced that its S&F; shares were no longer for sale and that it would remain a long-term investor in the firm.
The logical question now is, how come no other retailer or institutional investor wanted to take Casino’s stake in S&F;? Based solely on the firm’s fundamentals, there’s a gem of an asset here.
Though Smart & Final stores have been hurt by California’s recession, they are faring far better than many competitors. S&F;’s third-quarter earnings were $5.2 million, or 25 cents a share, flat with a year ago. But sales rose 11% to $265 million.
More significant, same-store sales were up 3.9% from a year earlier, indicating that S&F; customers either are spending more, or that the stores are grabbing market share from competitors. In contrast, same-store sales have been falling this year at other grocers. Vons Cos., for example, saw same-store sales drop 9.3% in the second quarter. (Its third-quarter report will be out next week.)
Longer-term, S&F;’s merchandising concept--small, non-membership, warehouse grocery stores catering to restaurants and other bulk buyers, as well as to individuals--appears to have significant growth potential if the firm can succeed elsewhere as it has in Southern California. Between 1986 and 1992, sales jumped from $335 million to $765 million; earnings leaped from $3.8 million to $14.4 million.
S&F; now has 133 stores, mostly in Southern California, but the firm has begun expanding into Nevada and Arizona. And the first S&F; store in Mexico will open in December in Tijuana. All told, S&F; will have opened 16 new stores this year and plans another 16 openings for next year, including its first stores in San Francisco and Oakland.
Then why no buyer for Casino’s S&F; stake? Certainly, the rush of consolidation in the warehouse club industry (witness Price Co.’s merger with Costco) has raised fears that the remaining players will be tougher competitors for S&F.; So far, though, S&F;’s hybrid wholesale/retail concept has fared well against bigger players.
Robert J. Emmons, S&F;’s chief executive, believes interested investors just can’t get over their fear of California’s economic slump. Yet in his view, the recession is a blessing in disguise, as S&F; continues to expand. “We’re seeing real estate opportunities we haven’t seen in years,” he says.
Even so, Emmons concedes that expansion costs will crimp earnings near-term. He has warned Wall Street not to expect bottom-line growth to resume until 1994, and that appears to mean the second half rather than the first. Wall Street now expects S&F; to earn 80 cents a share this year, 94 cents next. At $12.50, the stock’s price-to-earnings ratio based on the 1993 earnings estimate is 16.
Ron Baron, whose Baron Capital in New York is a large S&F; holder, insists the stock is “very, very cheap.” One of Baron’s investment rules is to buy only those stocks that have at least 50% appreciation potential within two years. “We think Smart & Final exceeds that,” he says.
One final note: Even if S&F;’s earnings come in under expectations in the short run, there’s good reason to believe that the stock’s downside is limited. Some Wall Streeters say national retailers may not be able to resist S&F; at a price under $10.
Also, Emmons confirms that management has mulled a leveraged buyout but decided against it.
One large shareholder insists that an LBO price of $15 to $17 a share would be financially feasible, if Casino were willing to exit in that price range.
Emmons, who owns 10% of the stock, won’t put a price tag on S&F;, but he says simply, “I think the company’s intrinsic long-term value is far better than what the market has priced it at today.”
Discount Bargain?
Smart & Final’s shares have sunk in recent months after the retailer’s majority shareholder decided to sell out. Now with the stock way down, the shareholder has opted not to sell. Weekly closes on NYSE, except latest:
Thursday: $12.50
